Stocks, politics and confirmation bias

Peter S. Cohan WALL & MAIN

Published Sunday March 24, 2013 at 6:00 am

In 2002, Daniel Kahneman, a professor at Princeton, won the Nobel Prize for economics for his role in inventing the field of behavioral economics. One of the many seemingly irrational human decision routines that he highlighted goes by the name of confirmation bias: how people embrace data that reinforces their world view, and dismiss information that undermines it.

When it comes to the stock market and the media, confirmation bias is in full display. Media outlets that dislike the party in the White House pick up on data that supports their belief that President Obama is bad for stocks. Other media outlets that tend to favor the Democratic Party, choose to highlight information that reinforces their decision to support it.

A March 6 email from attorney Stuart Hammer pits the Associated Press against The New York Times in a mini-case study of confirmation bias. Mr. Hammer pointed out that AP appears to have an anti-Democratic Party bias, noting a March 6 article suggesting that "Americans sold more stocks than they bought in 2012 for the fifth straight year."

By contrast, Mr. Hammer pointed out that a New York Times article by "Jeff Summer (sic) (noted that) Americans increased their investments in stocks last year by $76.7 billion."

In his struggle to reconcile the competing points of view, Mr. Hammer suggests that the AP article was "chosen for publication because of political reasons rather than as an insight into why the market is at a new high." I wonder whether he would suggest that The New York Times is similarly biased in favor of the party that's currently in power.

Setting aside Mr. Hammer's conclusions about media bias, I first want to point out that confirmation bias is a very powerful and dangerous phenomenon. The most recent example that comes to mind is a decision that was made in fall 2002 — the one that the U.S. should go to war against Iraqi leader Saddam Hussein.

Confirmation bias played a central role. The White House decided it wanted a war and it cherry-picked "evidence" — most notably, the false assertion that Mr. Hussein harbored so-called weapons of mass destruction that were never found — to support that conclusion. It also fired advisers who presented information to the president that contradicted the case for war.

If confirmation bias can be used to sell a war, it is far easier to accept that it could also be used to heckle the party in power when it comes to the stock market. In my view, the most important idea that investors need to understand about reporting on the stock market is that anyone who claims to understand the market is kidding himself.

The simple fact is nobody can explain why stocks move up and down.

Consider investor John Paulson. Mr. Paulson took home $4 billion in his 2007 paycheck by betting that sub-prime mortgages would collapse. But in recent years, he has watched his fortunes plunge, betting on gold and other financial sectors that have defied his supposed market wisdom.

If people like Mr. Paulson cannot explain why markets move, how can we mere mortals have any hope of doing so? This inability to explain stocks is not mere jibber-jabber. After all, more and more people are being forced to choose where to invest their retirement savings. They must decide whether to buy stocks, bonds, money market instruments, individual stocks or other investments and hope that they will have enough left over after they retire to keep paying their bills.

But reporting on the stock market is notably unhelpful for such amateur-made-professional investors. Reasons cited for why the stock market goes up and down track closely with political bias, or a general view that investors buy and sell based on the latest political and economic headlines.

For example, CNBC is notably right of center. One of its reporters, Rick Santelli, is famous for ticking off the so-called tea party with his resentful comments about bailing out underwater mortgage holders.

Therefore, CNBC loves to highlight how each tiny dip in the stock market is a signal of an imminent collapse in stocks. Stoking such fears may fool some people into trading more each day, which boosts the revenues of CNBC advertisers. But it also reflects a persistent effort to highlight negative economic news while implicitly suggesting that it's the fault of the president.

But there are two simple facts that the public needs to know for its investment allocation decisions. Stocks have risen more under President Obama than they have under any president in the last 70 years — up an average of 22 percent since March 2009. The second best performer was Bill Clinton, under whom stocks rose an average of about 17.6 percent. The other fact is that the rising stock market has been accompanied by record corporate profits every year since 2010.

If you are biased toward having enough on which to retire, these facts suggest you should ignore the political reporting on stocks and buy stock index funds that mirror the averages that have risen an average of 7 percent a year over the last 200 plus years, according to Wharton's Jeremy Siegel. This choice will boost your odds of retiring with enough while keeping the stock brokers from enriching themselves in the process.

Peter Cohan of Marlboro heads a management consulting and venture capital firm, and teaches business strategy at Babson College. His email address is peter@petercohan.com.